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Exam 13: Capital Budgeting Decisions

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Question 51

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Ferris Company has an old machine that is fully depreciated but has a current salvage value of $5,000.The company wants to purchase a new machine that would cost $60,000 and have a five-year useful life and zero salvage value.Expected changes in annual revenues and expenses if the new machine is purchased are: $\begin{array}{lccc}\text { Increased revenues } & & \$ 63,000 \\\text { Increased expenses: } & & \\\quad \text { Salary of additional operator } &\$ 20,000 & \\\text { Supplies } & 9,000 & \\\text { Depreciation } 12,000 \\\text { Maintenance } & 4,000 & 45,000\\\text { Increased net income } & & \$ 18,000\end{array}$ (Ignore income taxes in this problem.) Required: a) What is the payback period on the new equipment? b) What is the simple rate of return on the new equipment?

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a) Investment required/Net annual cash i...

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Question 52

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Prince Company's required rate of return is 10%.The company is considering the purchase of three machines,as indicated below.Consider each machine independently. (Ignore income taxes in this problem.)B.c)Investment required/Net annual cash flow = Factor of the internal rate of return Required: a)Machine A will cost $25,000 and will have a useful life of 15 years.Its salvage value will be $1,000,and cost savings are projected at $3,500 per year.Calculate the machine's net present value. b)How much should Prince Company be willing to pay for Machine B if the machine promises annual cash inflows of $5,000 per year for eight years? c)Machine C has a projected life of ten years.What is the machine's internal rate of return if it costs $31,296 and will save $6,000 annually in cash operating costs? Would you recommend to Prince Company to purchase Machine C? Explain.

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Because the present value of the ca...

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Question 53

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Ursus,Inc.is considering a project that would have a ten-year life and would require a $2,000,000 investment in equipment.At the end of ten years,the project would terminate and the equipment would have no salvage value.The project would provide net income each year as follows: $\begin{array} { l r } \text { Sales } & \$ 2,000,000 \\\text { Less: Variable Expenses } & \$ 1,400,000 \\\text { Contribution Margin } & \$ 600,000 \\\text { Less: Fixed Expenses } & \$ 400,000 \\\text { Net Income } & \$ 200,000\end{array}$ All of the above items, except for depreciation of $200,000 a year, represent cash flows. The depreciation is included in the fixed expenses. The company's required rate of return is 12%. (Ignore income taxes in this problem.) Required: a) What is the project's net present value? b) What is the project's internal rate of return? c) What is the project's payback period? d) What is the project's simple rate of return?

Roy Company is trying to decide whether to invest in one of two projects: X or Z.Associated data for each investment project follow: $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\text { Project }$ $\begin{array}{lcc}&\mathrm{X}&\mathrm{Z}\\\text { Cost of equipment } & \$ 90,000 & \$ 140,000 \\\text { Useful life } & 6 \text { years } & 9 \text { years } \\\text { Annual net cash inflow } & \$ 25,000 & \$ 30,000 \\\text { Salvage value } & \$ 8,000 & \$ 12,000\end{array}$ The equipment for each project is in Class 22 with a 30% maximum CCA rate. The income tax rate is 30%. Roy's after-tax cost of capital is 12%. Required: a) Calculate the net present value of each project, and indicate which appears preferable in terms of net present value. b) Calculate the profitability index for each project, and indicate which project would be preferable using this investment criterion.

Parks Company is considering an investment proposal in which a working capital investment of $10,000 would be required.The investment would provide cash inflows of $2,000 per year for six years.The working capital would be released for use elsewhere when the project is completed.If the company's discount rate is 10%,what is the investment's net present value? (Ignore income taxes in this problem.)

Superstrut is considering replacing an old press that cost $80,000 six years ago with a new one that would cost $245,000.The old press has a net book value of $15,000 and could be sold for $5,000.The increased production of the new press would require an investment in additional working capital of $6,000.The company's tax rate is 40%.What would be Superstrut's net investment now in the project?

A company with $800,000 in operating assets is considering the purchase of a machine that costs $75,000 and which is expected to reduce operating costs by $20,000 each year.The payback period for this machine in years is closest to which of the following? (Ignore income taxes in this problem.)

The present value of a cash flow decreases as it moves further into the future.

When a company invests in equipment,it gets to immediately expense the cost of the equipment on the company's income tax return filed with Canada Customs and Revenue Agency (CCRA).

Why are the net present value and internal rate of return methods of capital budgeting superior to the payback method?

In order to receive $12,000 at the end of three years and $10,000 at the end of five years,how much must be invested now if you can earn 14% rate of return? (Ignore income taxes in this problem.)

The Baker Company purchased a piece of equipment with the following expected results: $\begin{array} { l r } \text { Useful Life } & 7 \text { years } \\\text { Yearly Net Cash Inflow } & \$ 50,000 \\\text { Salvage Value } & - 0 - \\\text { Internal Rate of Return } & 20 \% \\\text { Discount Rate } & 16 \%\end{array}$ What was the initial cost of the equipment? (Ignore income taxes in this problem.)

Depreciation expenses taken on financial reports are relevant for capital budgeting decisions because it affects the company's net income.

The present value concept considers both recovery of the original investment and return on the original investment.

The Regulations that accompany the Canadian Income Tax Act require that capital cost allowance (CCA)be calculated generally on a declining balance of each single depreciable asset.

General Manufacturing Company consists of several divisions, one of which is the Transportation Division. The company has decided to dispose of this division because it no longer fits the company's long-term strategy. An offer of $9,000,000 has been received from a prospective buyer. If General retained the division, the company would operate the division for only nine years, after which the division would no longer be needed and would be sold for $600,000. If the company retains the division, an immediate investment of $500,000 would need to be made to update equipment to current standards. Annual net operating cash flows would be $1,805,000 if the division is retained. The company's discount rate is 12%. (Ignore income taxes in this problem.) Required: Using the net present value method, determine whether General Manufacturing should accept or reject the offer made by the potential buyer.

The following information is available on a new piece of equipment: $\begin{array} { l r } \text { Cost of the Equipment } & \$ 21,720 \\\text { Annual Cash Inflows } & \$ 5,000 \\\text { Internal Rate of Return } & 16 \% \\\text { Required Rate of Return } & 10 \%\end{array}$ What is approximately the life of the equipment? (Ignore income taxes in this problem.)

Consider a machine that costs $115,000 now and has a useful life of seven years.This machine will require a major overhaul at the end of the fourth year that will cost X dollars.If the tax rate is 40%,and if the after-tax cash outflow for this overhaul is $3,600,what is the amount of X in dollars?

Sue Falls is the president of Sports,Inc.She is considering buying a new machine that would cost $14,125.Sue has determined that the new machine promises an internal rate of return of 12%,but Sue has misplaced the paper that gives the annual cost savings promised by the new machine.She does remember that the machine has a projected life of ten years.Based on these data,what are the annual cost savings? (Ignore income taxes in this problem.)

Suppose a machine costs $20,000 now,has an expected life of eight years,and will require a $7,000 overhaul at the end of the third year.If the tax rate is 40%,what would be the after-tax cost of this overhaul?